Islamic Finance: Islamic Sukuk By Goldman Sachs Causes Debate

A controversial plan by Goldman Sachs to issue an Islamic bond has ignited a wider debate on whether conventional banks in the West should be allowed to engage in Islamic finance.

At a major conference of Islamic scholars and bankers in London this week, much of the public and private discussion was devoted to whether growing Western interest in Islamic finance could damage the industry by compromising its religious principles.

Some participants argued investment banks such as Goldman should be banned from issuing Islamic bonds, or sukuk, because the funds they raised could help to finance other parts of their business that did not comply with sharia or Islamic law.

“A conventional bank, with the exception of multilateral development banks like the World Bank and the Asian Development Bank, should not be allowed to issue sukuk,” said Badlisyah Abdul Ghani, chief executive of CIMB Islamic, the Islamic unit of CIMB Group, Malaysia’s second biggest bank.

“The basic principle of Islamic finance is that you should only finance activities that are consistent with sharia, and conventional rib (interest) is not,” he told Reuters on the sidelines of the Euromoney Islamic Finance Summit.

Other participants said the industry could not bar conventional banks and should focus instead on ensuring that each of their Islamic transactions complied with sharia law.

“The fact that these sukuk are issued by Goldman Sachs or by another Western bank really makes no difference whatsoever as far as judgement of sharia is concerned,” Mohamed Elgari, a prominent Islamic scholar, said during a panel discussion.

“An institution has no religion and therefore cannot be judged on religious grounds. Our judgement is always on the structure of the transaction, and whether it is permissible or not and had the necessary sharia requirements.”

The debate could affect Western access to a fast-growing area of the financial world. Estimated at over $100 billion, global sukuk issuance is still dwarfed by trillions of dollars worth of conventional bonds. But Western banks are becoming more involved in Islamic finance as its pool of wealthy, conservative investors from the Gulf and southeast Asia makes it a stable source of funds during the global financial crisis.

HSBC’s Middle East unit became the first Western bank to issue a sukuk last May with a $500 million, five-year Islamic bond. France’s Credit Agricole said last October it was considering whether to issue a sukuk.

Goldman’s sukuk became controversial partly because for many investors, the U.S. investment bank embodies aggressive, sophisticated Western financial engineering.

It announced in October that it planned to issue a sukuk worth as much as $2 billion based on murabaha, a structure that instead of interest, which is banned by Islamic principles, uses a cost-plus-profit arrangement to pay investors.

Some Islamic finance analysts questioned whether the underlying structure of the sukuk was really murabaha, and suggested Goldman might use the proceeds of its sukuk to fund interest-based banking activities.

They also said the sukuk might violate a ban against pure monetary speculation if it traded between investors on the Irish Stock Exchange, where it would be registered, at levels other than par value.

The controversy has put the top authorities of Islamic finance in a difficult position. Big Western banks such as Goldman could help the industry grow by providing trading liquidity, trained personnel and access to Western investors. But the credibility of the industry could suffer if it is perceived to be manipulated by Western institutions.

Asked about the participation of Western banks, a top official of one of the international bodies which sets standards for the industry replied: “That’s a tough question — there is a sharia-compliant issue.

“It requires a seriousness of purpose and respect of Islamic finance, and if those two are not there, I am not sure how they would participate,” said the official, declining to be named because of the sensitivity of the issue.

He noted that Malaysia’s central bank, for example, stipulated Islamic banking activities could only be transacted by a licensed Islamic bank. But he added that this should not exclude Western banks from all involvement in the industry.

“Western banks can certainly participate in terms of underwriting and helping in structuring the products.

Most participants at the conference said there was unlikely to be any sustained, concerted push within the industry to exclude conventional or Western banks from areas of Islamic finance. Some big Western banks, such as HSBC, already operate well-established Islamic arms offering a range of services.

Any attempt to exclude conventional banks could also be thwarted by the industry’s decentralised structure.

Bodies such as the Malaysia-based Islamic Financial Services Board and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) set standards which they hope banks will follow, but they cannot impose rules; that is up to national regulators in each country.

Ultimately, therefore, the success of Islamic financial products offered by Western banks is likely to come down to whether investors choose to buy them. The Goldman case suggests they will.

Banking sources in the Gulf told Reuters this week that Goldman, which insists its planned sukuk obeys Islamic principles and will not be used to raise money for interest-based activities, was talking to potential Saudi Arabian buyers and was likely to have no problem in attracting enough demand.

A copy of the fatwa or Islamic ruling behind the Goldman sukuk, which was seen by Reuters, showed five sharia scholars had signed it. The AAOIFI’s guidelines stipulate that at least three scholars advising on a bond programme should approve it in writing before issuance.

However, the Goldman controversy could cause conventional banks to take more steps in future to allay potential concerns over whether they are following Islamic principles.

Aznan Hasan, one of the scholars who signed the Goldman fatwa, said there were no sharia-related problems with the sukuk. The intention to list on the Irish exchange is purely for tax purposes, he said. But he added that Goldman should consider more measures to address doubts.

“I personally think the issue now is what is the mechanism to ensure that it is not traded, and even if it is traded, that it’s traded at par, and they have to come up to us with a mechanism for that,” he told Reuters.

He said Goldman might issue an additional or complementary prospectus to address this aspect and describe how it would ensure proceeds of the sukuk were only used for sharia-compliant purposes. Goldman might also agree to issue a letter to its board of sharia scholars whenever it used the proceeds, or agree to quarterly audits, he added.

“If they can put all the mechanisms in there, then there shouldn’t be any problem,” said Hasan. “The murabaha is not a new one — there is nothing new in the structure.”

Another scholar, Sheikh Edam M. Ishaq, said the Goldman case might lead to institutional reforms in the industry and closer scrutiny of sukuk issues in general.

“There must be some regulatory body to monitor and ensure the compliance of these issues, otherwise sooner rather than later the attraction of sukuk as Islamic liquidity management instruments will lose a lot,” he said.

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